Share prices in Genius Brands (NASDAQ:GNUS) have fallen roughly 41% from a recent high of $3.06 a share on Jan. 27. The rally that got shares to that price was part of a retail-driven push into heavily shorted stocks that is now unraveling because of weak fundamentals.

Investors who still own Genius Brands should consider selling, because the company's cash-burning operations and penchant for equity dilution could lead to long-term declines in the stock price. 

Genius Brands is burning through cash

Billed as a potential "Netflix for kids" by CEO Andy Heyward, Genius Brands is a content management company that creates and licenses educational multimedia for toddlers up to tweens.

Downward arrow and stock chart with hundred dollar bill in background

Image source: Getty Images.

Genius Brands' flagship program, Kartoon Channel, is available on major platforms such as Amazon Prime, Apple TV+, and Comcast's Xfinity on Demand. The company has also developed a Netflix show called Llama Llama, which was renewed for a second season in 2018 (revenue recognition occurred in the third quarter of 2019). 

Genius Brands' shows probably aren't household names for most families, but you can find its content if you look hard enough. Unfortunately, these assets haven't created sustainable value for equity investors. 

Third-quarter revenue collapsed 92% year over year, from $3.4 million to roughly $274,000, after a significant decline in the television and home entertainment segment. The company didn't follow up its 2019 Llama Llama licensing to Netflix with a comparable deal in 2020. And despite the inconsistent revenue growth, General and Administrative costs soared by 45% to $3 million, leading to an operating loss of $3.4 million in the period. 

Investors face dilution 

Genius Brands sustains its operating losses through equity dilution. Despite poor business results, the company increased its cash and equivalents from roughly $305,000 in December 2019 to $50.5 million by September 2020. Management raised most of that capital by issuing new shares, which dilutes existing investors and can lead to stock underperformance if they don't create long-term value with the funds. 

In October 2020, Genius Brands announced yet another equity offering of 37.4 million shares for proceeds of roughly $58 million. The company may have used some of this cash to acquire marketing and media agency ChizComm and its advertisement buying division, Beacon Media. Management hasn't revealed how much ChizComm cost. And they have been tightlipped about the profit implications of the new business. 

According to CEO Andy Heyward, ChizComm is the largest purchaser of children's media in the U.S., with an annual spend of $100 million. Heyward notes that net commissions from the spending will aggregate to Genius Brands' revenue line, but he doesn't reveal whether the new business is profitable. This detail matters because if ChizComm isn't profitable, it will add to Genius Brands' operating losses and set the stage for further equity dilution in the future. 

Invest in fundamentals, not hype 

Genius Brands is one of several low-quality stocks that have surged due to speculative demand in recent weeks. But like other "meme stocks," the rollercoaster ride has ended in massive losses for many novice investors. Genius Brands has already given back most of its gains year to date. And the crash could intensify if the company doesn't get its operating losses and equity dilution under control.

Investors should consider jumping ship because of these unresolved challenges. 

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.